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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Fiscal Year Ended December 31, 2003
-- OR--
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number 333-108876
TXU Energy Company LLC
(Exact Name of Registrant as Specified in its Charter)
A Delaware Limited Liability Company 75-2967817
(State of Incorporation) (I.R.S. Employer
Identification No.)
1601 Bryan Street Dallas, TX 75201-3411 (214) 812-4600
(Address of Principal Executive Offices) (Registrant's Telephone Number)
(Zip Code)
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Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: None
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Indicate by check mark whether the registrants (1) have filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrants were required to file such reports), and (2) have been subject to
such filing requirements for the past 90 days. Yes X No
--- ----
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Securities Exchange Act). Yes No X
-- --
Aggregate market value of TXU Energy Company LLC common membership interests
held by non-affiliates: None
TXU Corp. indirectly owns all the common members' interests of TXU Energy
Company LLC.
TXU Energy Company LLC meets the conditions set forth in General Instructions
(I) (1) (a) and (b) of Form 10-K and is therefore filing this report with the
reduced disclosure format.
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DOCUMENTS INCORPORATED BY REFERENCE - None
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TABLE OF CONTENTS
Page
----
Glossary............................................................................................ ii
PART I
Items 1. and 2. BUSINESS and PROPERTIES............................................................ 1
TXU ENERGY COMPANY LLC AND SUBSIDIARIES.................................................... 1
TEXAS ELECTRIC INDUSTRY RESTRUCTURING...................................................... 1
DESCRIPTION OF OPERATIONS.................................................................. 3
ENVIRONMENTAL MATTERS...................................................................... 7
Item 3. LEGAL PROCEEDINGS.......................................................................... 9
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS........................................ 10
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS........................................................................ 11
Item 6. SELECTED FINANCIAL DATA.................................................................... 11
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS...................................................................... 11
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK................................. 11
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA................................................ 11
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE................................................................... 11
Item 9A. CONTROLS AND PROCEDURES.................................................................... 11
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT......................................... 12
Item 11. EXECUTIVE COMPENSATION..................................................................... 12
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT............................. 12
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS............................................. 12
Item 14. PRINCIPAL ACCOUNTING FEES AND SERVICES..................................................... 12
PART IV
Item 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K............................ 14
APPENDIX A - Financial Information of TXU Energy Company LLC
APPENDIX B - Exhibits to 2003 Form 10-K
Periodic reports on Form 10-K and Form 10-Q and current reports on Form 8-K that
contain financial information of TXU Energy Company LLC are made available to
the public, free of charge, on the TXU Corp. website at http://www.txucorp.com,
shortly after they have been filed with the Securities and Exchange Commission.
TXU Energy Company LLC will provide copies of current reports not posted on the
website upon request.
i
GLOSSARY
When the following terms and abbreviations appear in the text of this report,
they have the meanings indicated below.
1999 Restructuring Legislation........Legislation that restructured the electric
utility industry in Texas to provide
for competition
2002 Form 8-K.........................US Holdings' Current Report on Form 8-K
filed on February 26, 2003 for TXU Energy
with respect to its financial information
for the year ended December 31, 2002, and
Form 8-K filed September 16, 2003 to
reflect the impact of adopting SFAS 145 on
the financial information reported in the
Form 8-K filed on February 26, 2003
2002 Form 10-K........................US Holdings' Annual Report on Form 10-K
for the year ended December 31, 2002
2003 Form 10-K........................TXU Energy's Annual Report on Form 10-K
for the year ended December 31, 2003
APB Opinion 30........................Accounting Principles Board Opinion No.
30, "Reporting the Results of Operations -
Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary,
Unusual and Infrequently Occurring Events
and Transactions"
Bcf...................................billion cubic feet
Commission............................Public Utility Commission of Texas
EITF..................................Emerging Issues Task Force
EITF 98-10 ...........................EITF Issue No. 98-10, "Accounting for
Contracts Involved in Energy Trading and
Risk Management Activities"
EITF 01-8.............................EITF Issue No. 01-8, "Determining Whether
an Arrangement Contains a Lease"
EITF 02-3 ............................EITF Issue No. 02-3, "Issues Involved in
Accounting for Derivative Contracts Held
for Trading Purposes and Contracts
Involved in Energy Trading and Risk
Management Activities"
EITF 03-11............................EITF Issue No. 03-11, "Reporting Realized
Gains and Losses on Derivative Instruments
That Are Subject to FASB Statement No. 133
and Not `Held for Trading Purposes' As
Defined in EITF No. 02-3"
EPA...................................Environmental Protection Agency
ERCOT.................................Electric Reliability Council of Texas, the
Independent System Operator and the
regional reliability coordinator of the
various electricity systems within Texas
ERISA.................................Employee Retirement Income Security Act
FASB..................................Financial Accounting Standards Board, the
designated organization in the private
sector for establishing standards for
financial accounting and reporting
FERC..................................Federal Energy Regulatory Commission
FIN...................................Financial Accounting Standards Board
Interpretation
FIN 45................................FIN No. 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees,
Including Indirect Guarantees of
Indebtedness of Others - an Interpretation
of FASB Statements No. 5, 57, and 107 and
Rescission of FIN No. 34"
FIN 46................................FIN No. 46, "Consolidation of Variable
Interest Entities"
Fitch.................................Fitch Ratings, Ltd.
ii
GWh...................................gigawatt-hours
historical service territory..........US Holdings historical service territory,
largely in north Texas, at the time of
entering competition on January 1, 2002
IRS...................................Internal Revenue Service
kv....................................kilovolt
Moody's...............................Moody's Investors Services, Inc.
MW....................................megawatts
NRC...................................United States Nuclear Regulatory
Commission
Oncor.................................refers to Oncor Electric Delivery Company,
a subsidiary of US Holdings, and/or its
consolidated bankruptcy remote financing
subsidiary, Oncor Electric Delivery
Transition Bond Company LLC, depending on
context
POLR..................................provider of last resort of electricity to
certain customers under the Commission
rules interpreting the 1999 Restructuring
Legislation
Price-to-beat rate....................residential and small business customer
electricity rates established by the
Commission in the restructuring of the
Texas market that are required to be
charged in a REP's historical service
territories until January 1, 2005 or when
40% of the electricity consumed by such
customer classes is supplied by competing
REPs, adjusted periodically for changes
in fuel costs, and required to be
available to those customers until
January 1, 2007
REP...................................retail electric provider
S&P...................................Standard & Poor's, a division of the
McGraw Hill Companies
Sarbanes-Oxley........................Sarbanes - Oxley Act of 2002
SEC...................................United States Securities and Exchange
Commission
Settlement Plan.......................regulatory settlement plan that received
final approval by the Commission in
January 2003
SFAS..................................Statement of Financial Accounting
Standards issued by the FASB
SFAS 4................................SFAS No. 4, "Reporting Gains and Losses
from Extinguishment of Debt"
SFAS 34...............................SFAS No. 34, "Capitalization of Interest
Cost"
SFAS 71...............................SFAS No. 71, "Accounting for the Effect
of Certain Types of Regulation"
SFAS 87...............................SFAS No. 87, "Employers' Accounting for
Pensions"
SFAS 101..............................SFAS No. 101, "Regulated Enterprises -
Accounting for the Discontinuance of the
Application of FASB Statement No. 71"
SFAS 106..............................SFAS No. 106, "Employers' Accounting for
Postretirement Benefits Other Than
Pensions"
SFAS 109..............................SFAS No. 109, "Accounting for Income
Taxes"
SFAS 121..............................SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of"
SFAS 132..............................SFAS No. 132, "Employers' Disclosures
about Pensions and Postretirement
Benefits"
SFAS 133..............................SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities"
SFAS 140..............................SFAS No. 140, "Accounting for Transfers
and Servicing of Financial Assets and
Extinguishments of Liabilities a
replacement of FASB Statement 125"
SFAS 142..............................SFAS No. 142, "Goodwill and Other
Intangible Assets"
iii
SFAS 143..............................SFAS No. 143, "Accounting for Asset
Retirement Obligations"
SFAS 144..............................SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived
Assets"
SFAS 145..............................SFAS No. 145, "Rescission of FASB
Statements No. 4, 44 and 64, Amendment of
FASB Statement 13, and Technical
Corrections"
SFAS 146..............................SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal
Activities"
SFAS 149..............................SFAS No. 149, "Amendment of Statement
133 on Derivative Instruments and Hedging
Activities"
SFAS 150..............................SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics
of both Liabilities and Equity"
SG&A..................................selling, general and administrative
SOP 98-1..............................American Institute of Certified Public
Accountants Statement of Position 98-1,
"Accounting for the Cost of Computer
Software Developed or Obtained for
Internal Use"
TCEQ..................................Texas Commission on Environmental Quality
TXU Business Services.................TXU Business Services Company, a
subsidiary of TXU Corp.
TXU Corp..............................refers to TXU Corp. and/or its
consolidated subsidiaries, depending on
context
TXU Energy............................TXU Energy Company LLC, a subsidiary of
US Holdings, and refers to TXU Energy
and/or its consolidated subsidiaries,
depending on context
TXU Fuel..............................TXU Fuel Company, a subsidiary of
TXU Energy
TXU Gas...............................TXU Gas Company, a subsidiary of TXU Corp.
TXU Mining............................TXU Mining Company LP, a subsidiary of
TXU Energy
TXU Portfolio Management..............TXU Portfolio Management Company LP, a
subsidiary of TXU Energy
TXU SESCO.............................TXU SESCO Company, a subsidiary of TXU
Energy, which serves as a REP in ten
counties in the eastern and central parts
of Texas
US....................................United States of America
US GAAP...............................accounting principles generally accepted
in the US
US Holdings...........................TXU US Holdings Company, a subsidiary
of TXU Corp.
iv
PART I
Items 1. and 2. BUSINESS and PROPERTIES
TXU ENERGY COMPANY LLC AND SUBSIDIARIES
---------------------------------------
TXU Energy is engaged in power production (electricity generation) and
retail and wholesale sales of electricity and natural gas, primarily in the
state of Texas. TXU Energy engages in hedging and risk management activities to
mitigate commodity price risk.
TXU Energy's operations are conducted principally through the following
subsidiaries: TXU Generation Holdings Company LLC; TXU Portfolio Management
Company LP; TXU Energy Retail Company LP; TXU Fuel Company; and two coal mining
subsidiaries.
TXU Energy is managed as a single, integrated business; consequently,
there are no reportable business segments. At December 31, 2003, TXU Energy had
5,939 full-time employees, including 1,874 in a collective bargaining unit.
TEXAS ELECTRIC INDUSTRY RESTRUCTURING
-------------------------------------
RESTRUCTURING LEGISLATION
The 1999 Restructuring Legislation restructured the electric utility
industry in Texas and provided for a transition to competition in the generation
and retail sale of electricity. TXU Corp. disaggregated its electric utility
business, as required by the legislation, and restructured certain of its US
businesses as of January 1, 2002 resulting in two new business operations:
o Oncor - a utility regulated by the Commission that holds electricity
transmission and distribution assets and engages in electricity
delivery services.
o TXU Energy - a competitive business that holds the power generation
assets and engages in wholesale and retail energy sales and
hedging/risk management activities.
The relationships of these entities and their rights and obligations with
respect to their collective assets and liabilities are contractually described
in a master separation agreement executed in December 2001.
The operating assets of Oncor and TXU Energy are located principally in
the north-central, eastern and western parts of Texas.
A settlement of outstanding issues and other proceedings related to
implementation of the 1999 Restructuring Legislation received final and
non-appealable approval by the Commission in January 2003. See Note 14 for
further discussion.
In addition, as of January 1, 2002, certain other businesses within the
TXU Corp. system were transferred to TXU Energy, including TXU Gas' hedging and
risk management business and its unregulated retail commercial/industrial
(business) gas supply operation, as well as the fuel transportation and coal
mining subsidiaries that primarily service the generation operations.
Effective January 1, 2002, REPs affiliated with electricity delivery
utilities are required to charge residential and small business customers
located in their historical service territories "price-to-beat" rates
established by the Commission. TXU Energy, as a REP affiliated with an
electricity delivery utility, could not charge prices to customers in either of
those classes in the historical service territory that are different from the
price-to-beat rate, adjusted for fuel factor changes, until the earlier of
January 1, 2005 or the date on which 40% of the electricity consumed by
customers in that class is supplied by competing REPs. Thereafter, TXU Energy
may offer rates different from the price-to-beat rate to customers in that
class, but it must also continue to make the price-to-beat rate available for
residential and small business customers until January 1, 2007. Twice a year,
affiliated REPs may request that the Commission adjust the fuel factor component
of the price-to-beat rate based on changes in the market price of natural gas.
1
In December 2003, the Commission found that TXU Energy had met the 40%
requirement to be allowed to offer alternatives to the price-to-beat rate for
small business customers in the historical service territory.
Under amended Commission rules, effective in April 2003, affiliated REPs
of utilities are allowed to petition the Commission for an increase in the fuel
factor component of their price-to-beat rates if the average price of natural
gas futures increases more than 5% (10% if the petition is filed after November
15 of any year) from the level used to set the existing price-to-beat fuel
factor rate.
-- In January 2003, TXU Energy filed a request with the Commission under
the prior rules to increase the fuel factor component of its
price-to-beat rates. This request was approved and became effective in
early March 2003. As a result, average monthly residential bills rose
approximately 12%. Appeals of the Commission's order have been filed
and are currently pending in the Travis County, Texas District Court.
-- On July 23, 2003, TXU Energy filed another request with the Commission
to increase the fuel factor component of its price-to-beat rates. This
request was approved and became effective in late August 2003. As a
result, average monthly residential bills rose approximately 4%.
Appeals of the Commission's order have been filed and are currently
pending in the Travis County, Texas District Court.
Also, effective January 1, 2002, power generation companies affiliated
with electricity delivery utilities may charge unregulated prices in connection
with ERCOT wholesale power transactions. Estimated costs associated with nuclear
power plant decommissioning obligations continue to be recovered by Oncor as an
electricity delivery charge over the life of the plant.
REGULATORY SETTLEMENT PLAN
On December 31, 2001, US Holdings filed a Settlement Plan with the
Commission. It resolved all major pending issues related to US Holdings'
transition to competition pursuant to the 1999 Restructuring Legislation. The
Settlement Plan does not remove regulatory oversight of Oncor's business nor
does it eliminate TXU Energy's price-to-beat rates and related fuel adjustments.
The Settlement Plan became final in January 2003.
The major elements of the Settlement Plan are:
Excess Mitigation Credit -- Over the two-year period ended December 31,
2003, Oncor implemented a stranded cost excess mitigation credit in the amount
of $389 million (originally estimated to be $350 million), plus $26 million in
interest, applied as a reduction to delivery fees charged to all REPs, including
TXU Energy. The credit was funded by TXU Energy.
Regulatory Asset Securitization -- US Holdings received a financing order
authorizing the issuance of securitization bonds in the aggregate principal
amount of up to $1.3 billion to recover regulatory asset stranded costs and
other qualified costs. Accordingly, Oncor Electric Delivery Transition Bond
Company LLC, a bankruptcy remote financing subsidiary of Oncor, issued an
initial $500 million of securitization bonds in 2003 and is expected to issue
approximately $790 million in the first half of 2004. The principal and interest
on the bonds is recoverable through a delivery fee surcharge (transition charge)
to all REPs, including TXU Energy.
Retail Clawback Credit -- A retail clawback credit related to residential
customers was implemented in January 2004. The amount of the credit is equal to
the number of residential customers retained by TXU Energy in the historical
service territory on January 1, 2004, less the number of new residential
customers TXU Energy has added outside of the historical service territory as of
January 1, 2004, multiplied by $90. The estimated credit of $173 million will be
applied to delivery fees charged by Oncor to all REPs, including TXU Energy,
over a two-year period. TXU Energy funds the credit provided by Oncor. As the
amount of the credit will be based on numbers of customers over the related
two-year period, the liability is subject to future adjustments.
Stranded Costs and Fuel Cost Recovery -- TXU Energy's stranded costs, not
including regulatory assets, are fixed at zero. US Holdings will not seek to
recover its unrecovered fuel costs which existed at December 31, 2001. Also, it
will not conduct a final fuel cost reconciliation, which would have covered the
period from July 1998 until the beginning of competition in January 2002.
2
PROVIDER OF LAST RESORT
Through 2002, TXU Energy was the POLR for residential and small business
customers in those areas of ERCOT where customer choice was available outside
the historical service territory and was the POLR for large business customers
in the historical service territory. Under new POLR rules effective in September
2002, instead of being transferred to the POLR, non-paying residential and small
business customers served by affiliated REPs are subject to disconnection.
Non-paying residential and small business customers served by non-affiliated
REPs are transferred to the affiliated REP. Non-paying large business customers
can be disconnected by any REP if the customer's contract does not preclude it.
Thus, within the new POLR framework, the POLR provides electric service only to
customers who request POLR service, whose selected REP goes out of business, or
who are transferred to the POLR by other REPs for reasons other than
non-payment. No later than October 1, 2004, the Commission is expected to decide
whether all REPs should be permitted to disconnect non-paying customers.
Through a competitive bid process, the Commission selected a POLR to serve
for a two-year term beginning January 1, 2003, for several areas within Texas.
In areas for which no bids were submitted, the Commission selected the POLR by
lottery. TXU Energy did not bid to be the POLR, but was designated POLR through
lottery for residential and small business customers in certain West Texas
service areas and for small business customers in the Houston service area.
DESCRIPTION OF OPERATIONS
-------------------------
TXU Energy serves 2.6 million retail electric customers, of which 2.4
million are in the historical service territory. This territory, which is
located in the north-central, eastern and western parts of Texas, has an
estimated population in excess of 7 million, about one-third of the population
of Texas, and comprises 92 counties and 370 incorporated municipalities,
including Dallas/Fort Worth and surrounding suburbs, as well as Waco, Wichita
Falls, Odessa, Midland, Tyler and Killeen. The Dallas/Fort Worth area is a
diversified commercial and industrial center with substantial banking,
insurance, telecommunications, electronics, aerospace, petrochemical and
specialized steel manufacturing, and automotive and aircraft assembly. The
historical service territory served includes major portions of the oil and gas
fields in the Permian Basin and East Texas, as well as substantial farming and
ranching sections of the state. TXU Energy also provides retail electric service
in other areas of ERCOT now open to competition, including the Houston and
Corpus Christi areas.
Texas is one of the fastest growing states in the nation and is considered
by many to be one of the more successful deregulated energy markets in the U.S.
As a result, competition is expected to continue to increase.
POWER PRODUCTION
TXU Energy's power generating facilities provide TXU Energy with the
capability to supply a significant portion of the wholesale power market demand
in Texas, particularly in the North Texas market, at competitive production
costs. As part of TXU Energy's integrated business portfolio, much of the low
cost nuclear powered and lignite/coal-fired (base load) generation is available
to supply the power demands of its retail customers and other competitive REPs.
The power fleet in Texas consists of 22 owned or leased plants with
generating capacity fueled as follows: 2,300 MW nuclear; 5,837 MW coal/lignite;
and 10,881 MW gas/oil. TXU Energy supplies its retail customer base from its
power fleet as well as through long-term power supply agreements and purchases
in the wholesale markets. The power generating plants and other important
properties of TXU Energy are located primarily on land owned in fee simple. TXU
Energy has sold and may from time to time sell generation assets to reduce its
position in the Texas market and provide funds for other investments or to
reduce debt.
TXU Energy is one of the largest purchasers of wind-generated energy in
Texas and the US. TXU Energy currently purchases energy from over 579 MW of wind
projects located in West Texas. TXU Energy expects to continue to add additional
wind generation to its portfolio as commercial opportunities become available.
Nuclear-Powered Production Assets -- TXU Energy owns and operates two
nuclear-fueled electricity generation units at the Comanche Peak plant, each of
which is designed for a capacity of 1,150 MW.
3
TXU Energy has on hand, or has contracted for, enrichment services through
mid-2006 and fabrication services through 2011 for its nuclear units. TXU Energy
is finalizing supply contracts for the purchase of uranium and conversion to
meet its needs through mid-2006 and does not anticipate any problems in
completing the contracts. TXU Energy does not anticipate any difficulties
procuring raw materials and services beyond these dates.
TXU Energy's onsite spent nuclear fuel storage capability is sufficient to
accommodate the operation of Comanche Peak through the year 2017, while
maintaining the capability to off-load the core of one of the nuclear-fueled
generating units.
Under current regulatory licenses, nuclear decommissioning activities are
projected to begin in 2030 for Comanche Peak Unit 1 and 2033 for Unit 2 and
common facilities. Since January 1, 2002, projected decommissioning costs are
being recovered from Oncor's customers through a delivery charge based upon a
1997 site-specific study, adjusted for changes in the value of trust fund
assets, through rates placed into effect under the 2001 Unbundled Cost of
Service filing.
The Comanche Peak nuclear-powered generation units were originally
estimated to have a useful life of 40 years, based on the life of the operating
licenses granted by the NRC. Over the last several years, the NRC has granted
20-year extensions to the initial 40-year terms for several commercial power
reactors. Based on these extensions and current expectations of industry
practice, the useful life of the Comanche Peak nuclear-powered generation units
is now estimated to be 60 years. TXU Energy expects to file a license extension
request in accordance with timing and other provisions established by the NRC.
(See Note 1 to Financial Statements under Property, Plant and Equipment, for a
discussion of the change in depreciable lives for accounting purposes).
Lignite/Coal -Fired Production Assets -- Lignite is used as the primary
fuel for two units at the Big Brown generating plant, three units at the
Monticello generating plant, three units at the Martin Lake generating plant,
and one unit at the Sandow generating plant, having an aggregate capacity of
5,837 MW. TXU Energy's lignite units have been constructed adjacent to surface
minable lignite reserves. TXU Energy owns in fee simple or has under lease
proven reserves dedicated to the Big Brown, Monticello and Martin Lake
generating plants. TXU Energy utilizes owned and/or leased equipment to remove
the overburden and recover the lignite. Approximately 75% of the fuel used at
TXU Energy's lignite plants in 2003 was supplied from owned or leased lignite.
TXU Energy supplements its lignite fuel at Big Brown, Monticello and
Martin Lake with western coal from the Powder River Basin in Wyoming. The coal
is purchased from multiple suppliers under contracts of various lengths and is
transported from the Powder River Basin to TXU Energy's generating plants by
railcar. Approximately 25% of the fuel used at TXU Energy's lignite plants in
2003 was supplied from western coal under these contracts. Based on its current
usage, which includes the use of western coal to supplement its lignite
reserves, TXU Energy believes that it has sufficient lignite reserves and access
to western coal resources for its generating needs in the foreseeable future.
Gas/Oil-Fired Production Assets -- TXU Energy has eighteen gas/oil-fueled
plants, including a plant located in Pedricktown, New Jersey, with an aggregate
capacity of 11,003 MW. A significant portion of the gas/oil generating plants
have the ability to switch between gas and fuel oil. Gas/oil fuel requirements
for 2003 were provided through a mix of contracts with producers at the wellhead
and contracts with commercial suppliers. Fuel oil can be stored at 15 of the
principally gas-fueled generating plants. At January 1, 2004, TXU Energy had
fuel oil storage capacity sufficient to accommodate approximately 5.5 million
barrels of oil and had approximately one million barrels of oil in inventory.
Capacity Auction -- To encourage competition in the ERCOT region, each
power generation company owning 400 MW or more of installed generating capacity
must annually offer to sell at auction entitlements to 15% of the output of its
installed generating capacity. Such auction sales cannot be to an affiliated
REP. The obligation of TXU Energy to sell capacity entitlements at auction
continues until the earlier of January 1, 2007 or the date the Commission
determines that 40% or more of the electric power consumed by residential and
small business customers within the affiliated delivery utility certificated
service area before the onset of customer choice is provided by non-affiliated
REPs. The October 2002 auction offered one-year and monthly entitlements for
2003 only. Not all of the entitlements offered in the October auction were sold;
however, TXU Energy did re-offer these unsold entitlements in subsequent
auctions held in November 2002 and throughout 2003. In 2003, TXU Energy held
capacity auctions in March, July and August for 2003 capacity, and in September
and November for 2004 capacity. TXU Energy met its capacity auction obligations
for 2003. The next auctions for the remaining 2004 capacity obligations are
scheduled for March and July 2004.
4
NATURAL GAS OPERATIONS
TXU Energy's natural gas operations in Texas include pipelines, storage
facilities, well-head production contracts, transportation agreements and
storage leases. Natural gas is purchased for internal use in the generation of
power, as well as for sale in wholesale markets and to large business customers.
Transportation services are provided to TXU Energy's generation operations and
third parties. Because of the correlation of natural gas and power prices, TXU
Energy's natural gas operations provide opportunities to hedge its margins on
power sales.
TXU Energy owns and operates an intrastate natural gas pipeline system
with approximately 1,900 miles of pipeline facilities which extends from the
gas-producing area of the Permian Basin in West Texas to the East Texas gas
fields and southward to the Gulf Coast area. The pipeline facilities were
originally built solely to serve US Holdings' generating plants. In keeping with
deregulation principles, this network now offers transportation service to third
parties at competitive prices.
TXU Energy also owns and operates two underground gas storage facilities
with a usable capacity of 14.0 Bcf. TXU Energy holds a portion of this storage
capacity for use during periods of peak demand to meet seasonal and other
fluctuations or interruption of deliveries by gas suppliers. Under normal
operating conditions, up to 400 million cubic feet can be withdrawn each day for
a ten-day period, with withdrawals at lower rates thereafter.
RETAIL
Regulatory restructuring in Texas has resulted in competitive markets
within the state, thus presenting additional opportunities for growth
accompanied by the introduction of competitive pressures. Texas is one of the
fastest growing states in the nation with a diverse and resilient economy and,
as a result, has attracted a number of competitors into the retail electricity
market. TXU Energy, as an active participant in this competitive market, is
marketing its services in Texas to add new customers and to retain its existing
customers.
Based on the latest data provided by ERCOT (November 2003), approximately
14% of all customers in ERCOT areas open to customer choice had elected to
switch providers. At the present time, 53 REPs are certified to compete within
the state of Texas.
TXU Energy believes that the scale derived from a large retail portfolio
provides the platform for a profitable operation by, among other things,
reducing the costs of service and billing per customer. TXU Energy emphasizes
its identification with the TXU brand and reputation. TXU Energy uses a value
pricing approach by customizing its products to each customer segment with
service enhancements that are known to be valued by customers in those segments.
With its approach, TXU Energy intends to achieve substantially higher customer
loyalty and enhanced profit margins, while reducing the costs associated with
customers frequently switching suppliers.
TXU Energy has invested in customer-related infrastructure and uses its
customer relationships, technology operating platforms, marketing, customer
service operations and customer loyalty to actively compete to retain its
customer base and to add customers.
5
PORTFOLIO MANAGEMENT
Portfolio management refers to risk management and value creation
activities undertaken to balance customer demand for energy with the supply of
energy in an economically efficient and effective manner. Retail and wholesale
demand is generally greater than volumes that can be supplied by TXU Energy's
base load production. Portfolio management acts to provide additional supply
balancing through TXU Energy's gas/oil-fired generation or purchases of power.
The portfolio management operation manages the commodity volume and price risks
inherent in TXU Energy's generation and sales operations through supply
structuring, pricing and risk management activities. Risk management activities
include hedging both future power sales and purchases of fuel supplies for the
generation plants. The portfolio management operation also is responsible for
the efficient dispatch of power from its generation plants.
In its risk management activities, TXU Energy enters into physical
delivery contracts, financial contracts that are traded on exchanges and
"over-the-counter" and bilateral contracts with customers. Physical delivery
contracts relate to the purchase and sale of electricity and gas primarily in
the wholesale markets in Texas and to a limited extent in select Northeast
markets in North America. TXU Energy's risk management activities consist
largely of hedging transactions, with speculative trading representing a small
fraction of such activity.
TXU Energy manages its exposure to price risk within established
transactional policies and limits. TXU Energy targets best practices in risk
management and risk control by employing proven principles used by financial
institutions. These controls have been structured so that they are practical in
application and consistent with stated business objectives. Portfolio management
revalues TXU Energy's exposures daily using integrated energy systems to capture
value and mitigate risks. A risk management forum meets regularly to ensure that
transactional practices comply with its prior approval of commodities,
instruments, exchanges and markets. Transactional risks are monitored and limits
are enforced to comply with established TXU Corp. policy requirements. Risk
assessment is segregated and operated separately from compliance and enforcement
to ensure independence, accountability and integrity of actions. TXU Corp. has a
strict disciplinary program to address any violations of its risk management
policy requirements. TXU Energy also periodically reviews these policies to
ensure they are responsive to changing market and business conditions. These
policies are designed to protect earnings, cash flows and credit ratings.
COMPETITIVE STRATEGY
TXU Energy's strategy is to defend and build its customer base in the
competitive Texas market and to accomplish this through the operation of a
single, integrated energy business managing a portfolio of assets. Achieving
operational excellence, more cost efficient processes and enhanced credibility
and reputation are all critical elements for executing on that strategy.
TXU Energy will continue to focus on sustaining its leading position in
the Texas market and being in position to move quickly toward capturing new
opportunities outside of Texas as they arise.
One of TXU Energy's key competitive strengths is its ability to produce
electricity at low variable costs in a market in which power prices are set by
gas-fired generation. New gas-fired capacity, while generally more efficient to
operate than existing gas/oil-fired capacity due to technological advances, is
subject to the volatility and increasing cost of natural gas fuel. On the other
hand, base load nuclear and lignite/coal plants have lower variable production
costs than even new gas-fired plants at current average market gas prices.
Another competitive strength for TXU Energy is the diversity of its generation
fleet. Due to the higher variable operating and fuel costs of its gas/oil-fired
units, as compared to its lignite/coal and nuclear units, production from TXU
Energy's gas/oil units is more susceptible to being displaced by the more
efficient units being constructed. This positions TXU Energy's gas/oil units to
run during intermediate and peak load periods when prices are higher and
provides more opportunities for hedging activities and increased market
liquidity.
Retail competition has remained steady in Texas with several large
participants broadly extending their marketing across all customer segments and
all geographic areas of competition. TXU Energy has successfully executed
similar marketing programs while retaining the majority of its incumbent
residential customer base.
6
TXU Energy believes that the ERCOT region presents an attractive
competitive electric service market due to the following factors:
o gas-fired plants are expected to set the price of generation during a
substantial portion of the year, providing an opportunity for TXU
Energy to benefit from its nuclear and lignite/coal units' fuel cost
advantages;
o peak demand is expected to grow at an average rate of approximately
3% per year;
o it is a sizeable market with approximately 62 gigawatts (GW) of peak
demand and approximately 35 GW of average demand; and
o there is no mandatory power pool structure.
Reserve margins for ERCOT, based upon existing capacity and planned
capacity with interconnection agreements, are expected to be 29% in 2004, 25% in
2005, 22% in 2006, 18% in 2007, and 15% in 2008.
Outside Texas -- Energy industry restructuring, although proceeding well
in Texas, has not had similar success in other parts of the U.S. As early as
2000, optimism for national legislation and increased opening of competitive
markets began to alter the strategy of many industry participants. The
establishment of Regional Transmission Organizations and open access for both
wholesale and retail customers were on the horizon. Together with increasing
customer demand for lower priced electricity and other energy services, these
measures were expected to have accelerated the industry's movement toward a
more competitive pricing and cost structure.
Many states, faced with this increasing pressure from legislative bodies
(federal and state) to become more competitive while adhering to certain
continued regulatory requirements, along with changing economic conditions and
rapid technological changes, put forth deregulation plans that have since been
deferred or changed. The result is delayed restructuring. New entry by retailers
as well as by merchant generators in states other than Texas has been slowed.
The continued uncertainty regarding many FERC policies as well as Federal
legislation have delayed the opening of new retail markets and decreased the
economic viability for merchant generation.
Customers -- There are no individually significant customers upon which
TXU Energy's business or results of operations are highly dependent.
REGULATION AND RATES
See Texas Electric Industry Restructuring above for a description of the
significant regulatory provisions relating to the deregulation of the Texas
electric industry.
TXU Energy is exempt from the provisions of the Public Utility Holding
Company Act of 1935, except Section 9(a)(2) which relates to the acquisition of
securities of public utility companies and Section 33 which relates to the
acquisition of foreign (non-US) utility companies.
TXU Energy is an exempt wholesale generator under the Federal Power Act
and is subject to the jurisdiction of the NRC with respect to its nuclear power
plant. NRC regulations govern the granting of licenses for the construction and
operation of nuclear power plants and subject such plants to continuing review
and regulation. TXU Energy also holds a power marketer license from FERC.
ENVIRONMENTAL MATTERS
---------------------
TXU Energy is subject to extensive environmental regulation by
governmental authorities. In operating its facilities, TXU Energy is required to
comply with numerous environmental laws and regulations, and to obtain numerous
governmental permits and approvals. If TXU Energy fails to comply with these
requirements, it could be subject to civil or criminal liability and fines.
Existing environmental laws and regulations could be revised or reinterpreted
and new laws and regulations could be adopted or become applicable to TXU Energy
or its facilities, including potential regulatory and enforcement developments
related to air emissions.
7
TXU Energy may not be able to obtain or maintain all required
environmental regulatory approvals. If there is a delay in obtaining any
required environmental regulatory approvals or if TXU Energy fails to obtain,
maintain or comply with the terms of any such approval, the operation of its
facilities could be stopped or become subject to additional costs. Further, at
some of TXU Energy's older facilities, including base load lignite and coal
plants, it may be uneconomical for TXU Energy to install the necessary
compliance equipment, which may cause TXU Energy to shut down those facilities.
In addition, TXU Energy may be responsible for any on-site liabilities
associated with the environmental condition of facilities that it has acquired
or developed regardless of when the liabilities arose and whether they are known
or unknown. In connection with acquisitions and sales of assets, TXU Energy may
obtain, or be required to provide, indemnification against certain environmental
liabilities. Another party could fail to meet its indemnification obligations to
TXU Energy.
Air -- Under the Texas Clean Air Act, the TCEQ has jurisdiction over the
permissible level of air contaminant emissions from, and permitting requirements
for, generating, mining and gas delivery facilities located within the State of
Texas. The New Jersey Department of Environmental Protection has jurisdiction
over the emissions from TXU Energy's generation facility in New Jersey. In
addition, the new source performance standards of the EPA promulgated under the
Federal Clean Air Act, as amended (Clean Air Act), are being implemented by the
TCEQ, and are applicable to certain generating units and ancillary equipment.
TXU Energy's generation plants and mining equipment operate in compliance with
applicable regulations, permits and emission standards promulgated pursuant to
these acts.
The Clean Air Act includes provisions which, among other things, place
limits on the sulfur dioxide (SO2) and nitrogen oxides (NOx) emissions produced
by certain generation plants. In addition to the new source performance
standards applicable to SO2 and NOx, the Clean Air Act requires that
fossil-fueled plants have sufficient SO2 emission allowances and meet certain
NOx emission standards. TXU Energy's generation plants meet the SO2 allowance
requirements and NOx emission rates. In addition, the EPA recently proposed new
requirements calling for electricity generation facilities in 28 states and the
District of Columbia to further reduce emissions of NOx and SO2. TXU Energy will
be required to make additional emissions reductions and incur associated costs
under this proposal if it is finalized in its current form.
In January 2004, the EPA issued a proposed rule to regulate mercury
emissions from power plants with the expectation that a final rule will be
issued by December 2004 with an implementation date in 2008. Two different
regulatory approaches are considered in the announcement and the final form of
the rule is unknown, It is likely that some costs, which could be material, will
be incurred for installation of additional control equipment and for facility
operations and maintenance.
The EPA has also issued rules for controlling regional haze; the impact of
these rules is unknown at this time because the TCEQ has not yet implemented the
regional haze requirements.
The Bush Administration is addressing greenhouse gas emissions through its
greenhouse gas emissions intensity reduction Climate VISION program. The Bush
Administration and EPA have proposed the Clear Skies legislative initiative
calling for reductions of SO2, NOx, and mercury from electricity generation
facilities over a 15-year period. Some legislative proposals for additional
regulation of SO2, NOx, mercury and carbon dioxide recently have been considered
at the federal level and it is expected that additional similar proposals will
be made in the future. TXU Energy continues to participate in a voluntary
greenhouse gas emission reduction program and since 1995 has reported the
results of its program annually to the U.S. Department of Energy. TXU Energy is
also participating in a new voluntary electric utility industry sector climate
change initiative in partnership with the Department of Energy. TXU Energy
continues to assess the financial and operational risks posed by future
regulatory or policy changes pertaining to greenhouse gas emissions and multiple
emissions, but because these proposals are in the formative stages, TXU Energy
is unable to predict their future impacts on the financial condition and
operations of TXU Energy.
Major air pollution control provisions of the 1999 Restructuring
Legislation required a 50% reduction in NOx emissions and a 25% reduction in SO2
emissions from "grandfathered" electric utility generation plants. The first
compliance period is for the year beginning May 1, 2003 through April 30, 2004.
TXU Energy has obtained all permits required for the "grandfathered" plants by
the 1999 Restructuring Legislation and has completed a construction program to
install control equipment to achieve the required reductions. TXU Energy fully
anticipates that it will be in compliance with the requirements at the end of
the first compliance period.
8
In 2001, the Texas Clean Air Act was amended to require that
"grandfathered" facilities, other than electric utility generation plants, apply
for permits. TXU Energy anticipates that the permits can be obtained for their
"grandfathered" facilities without significant effects on the costs of operating
these facilities.
The TCEQ has also adopted revisions to its State Implementation Plan (SIP)
rules that require an 89% reduction in NOx emissions from electricity generation
plants in the Dallas-Fort Worth ozone non-attainment area and a 51% reduction in
NOx emissions from electricity generation plants in East and Central Texas. Full
compliance is required by May 1, 2005. TXU Energy has already made significant
NOx emissions reductions to achieve the 51% reduction requirements of the 1999
Restructuring Legislation, but anticipates that additional reductions and/or
modifications in plant operations will be required to achieve the 89% reductions
called for in the SIP rules. Additionally, the TCEQ is expected to propose new
SIP rules in 2004 to deal with 1-hour and 8-hour ozone standards. These rules
could require further NOx emissions reductions from certain TXU Energy
facilities.
Water -- The TCEQ and the EPA have jurisdiction over water discharges
(including storm water) from all domestic facilities. Facilities of TXU Energy
are presently in compliance with applicable state and federal requirements
relating to discharge of pollutants into the water. TXU Energy holds all
required waste water discharge permits from the TCEQ for facilities in operation
and has applied for or obtained necessary permits for facilities under
construction. TXU Energy believes it can satisfy the requirements necessary to
obtain any required permits or renewals. Clean Water Act Section 316(b)
regulations pertaining to existing water intake structures are being developed
by the EPA with publication scheduled for early 2004. TXU Energy is unable to
predict at this time the impacts of these regulations.
Other -- Diversion, impoundment and withdrawal of water for cooling and
other purposes are subject to the jurisdiction of the TCEQ. TXU Energy possesses
all necessary permits for these activities from the TCEQ for its present
operations.
Treatment, storage and disposal of solid and hazardous waste are regulated
at the state level under the Texas Solid Waste Disposal Act and at the federal
level under the Resource Conservation and Recovery Act of 1976, as amended, and
the Toxic Substances Control Act. The EPA has issued regulations under the
Resource Conservation and Recovery Act of 1976 and the Toxic Substances Control
Act, and the TCEQ have issued regulations under the Texas Solid Waste Disposal
Act applicable to facilities of TXU Energy. TXU Energy has registered solid
waste disposal sites and has obtained or applied for such permits as are
required by such regulations.
Under the federal Low-Level Radioactive Waste Policy Act of 1980, as
amended, the State of Texas is required to provide, either on its own or jointly
with other states in a compact, for the disposal of all low-level radioactive
waste generated within the state. The State of Texas has agreed to a compact
with the States of Maine and Vermont for a disposal facility that would be
located in Texas. That compact was ratified by Congress and signed by the
President in 1998. The State of Texas had proposed to license a disposal site in
Hudspeth County, Texas, but in October 1998, the TCEQ denied that license
application. In 2003, the State of Texas enacted legislation allowing a private
entity to be licensed to accept low-level radioactive waste for disposal. TXU
Energy intends to continue to ship low-level waste material off-site for as long
as an alternative disposal site is available. Should existing off-site disposal
become unavailable, the low-level waste material will be stored on-site. TXU
Energy's on-site storage capacity is expected to be adequate until other
off-site facilities become available. (See Power Production - Nuclear Production
Assets above.)
Environmental Capital Expenditures -- Capital expenditures for TXU
Energy's environmental projects were $27 million in 2003 and are expected to be
about $18 million in 2004.
Item 3. LEGAL PROCEEDINGS
On July 7, 2003, a lawsuit was filed by Texas Commercial Energy (TCE) in
the United States District Court for the Southern District of Texas, Corpus
Christi Division, against TXU Energy and certain of its subsidiaries, as well as
various other wholesale market participants doing business in ERCOT, claiming
generally that defendants engaged in market manipulation, in violation of
antitrust and other laws, primarily during the period of extreme weather
conditions in late February 2003. An amended complaint was filed on February 3,
2004 that joined additional, unaffiliated defendants. Three retail electric
providers have filed motions for leave to intervene in the action alleging
claims substantially identical to TCE's. In addition, approximately 25 purported
9
former customers of TCE have filed a motion to intervene in the action alleging
claims substantially identical to TCE's, both on their own behalf and on behalf
of a putative class of all former customers of TCE. TXU Energy believes that it
has not committed any violation of the antitrust laws and the Commission's
investigation of the market conditions in late February 2003 has not resulted in
any findings adverse to TXU Energy. Accordingly, TXU Energy believes that TCE's
and the interveners' claims against TXU Energy and its subsidiary companies are
without merit and TXU Energy and its subsidiaries intend to vigorously defend
the lawsuit. TXU Energy is unable to estimate any possible loss or predict the
outcome of this action.
On April 28, 2003, a lawsuit was filed by a former employee of TXU
Portfolio Management in the United States District Court for the Northern
District of Texas, Dallas Division, against TXU Corp., TXU Energy and TXU
Portfolio Management. Plaintiff asserts claims under Section 806 of
Sarbanes-Oxley arising from plaintiff's employment termination and claims for
breach of contract relating to payment of certain bonuses. Plaintiff seeks back
pay, payment of bonuses and alternatively, reinstatement or future compensation,
including bonuses. TXU Corp. believes the plaintiff's claims are without merit.
The plaintiff was terminated as the result of a reduction in force, not as a
reaction to any concerns the plaintiff had expressed, and plaintiff was not in a
position with TXU Portfolio Management such that he had knowledge or information
that would qualify the plaintiff to evaluate TXU Corp.'s financial statements or
assess the adequacy of TXU Corp.'s financial disclosures. Thus, TXU Corp. does
not believe that there is any merit to the plaintiff's claims under
Sarbanes-Oxley. Accordingly, TXU Corp., TXU Energy and TXU Portfolio Management
intend to vigorously defend the litigation. While TXU Corp., TXU Energy and TXU
Portfolio Management dispute the plaintiff's claims, TXU Corp. is unable to
predict the outcome of this litigation or the possible loss in the event of an
adverse judgment.
On March 10, 2003, a lawsuit was filed by Kimberly P. Killebrew in the
United States District Court for the Eastern District of Texas, Lufkin Division,
against TXU Corp. and TXU Portfolio Management, asserting generally that
defendants engaged in manipulation of the wholesale electric market, in
violation of antitrust and other laws. This case has been transferred to the
Beaumont Division of the Eastern District of Texas. This action is brought by an
individual, alleged to be a retail consumer of electricity, on behalf of herself
and as a proposed representative of a putative class of retail purchasers of
electricity that are similarly situated. On September 15, 2003, defendants filed
a motion to dismiss the lawsuit and a motion to transfer the case to the
Northern District of Texas, Dallas Division. TXU Corp. believes that the
plaintiff lacks standing to assert any antitrust claims against TXU Corp. or TXU
Portfolio Management, and that defendants have not violated antitrust laws or
other laws as claimed by the plaintiff. Therefore, TXU Corp. believes that
plaintiff's claims are without merit and plans to vigorously defend the lawsuit.
TXU Corp. is unable to estimate any possible loss or predict the outcome of this
action.
General -- In addition to the above, TXU Energy and its subsidiaries are
involved in various other legal and administrative proceedings the ultimate
resolution of which, in the opinion of each, should not have a material effect
upon their financial position, results of operations or cash flows.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
10
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Not applicable. All of TXU Energy's common membership interests are owned
by US Holdings.
Item 6. SELECTED FINANCIAL DATA
The information required hereunder for TXU Energy is set forth under
Selected Financial Data included in Appendix A to this report.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The information required hereunder for TXU Energy is set forth under
Management's Discussion and Analysis of Financial Condition and Results of
Operations included in Appendix A to this report.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required hereunder for TXU Energy is set forth in
Management's Discussion and Analysis of Financial Condition and Results of
Operations included in Appendix A to this report.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required hereunder for TXU Energy is set forth under
Statement of Responsibility, Independent Auditors' Report, Statements of
Consolidated Income, Statements of Consolidated Comprehensive Income, Statements
of Consolidated Cash Flows, Consolidated Balance Sheets, Statements of
Consolidated Members Interests and Notes to Financial Statements included in
Appendix A to this report.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
Item 9A. CONTROLS AND PROCEDURES
An evaluation was performed under the supervision and with the
participation of TXU Energy's management, including the principal executive
officer and principal financial officer, of the effectiveness of the design and
operation of the disclosure controls and procedures in effect as of December 31,
2003. Based on the evaluation performed, TXU Energy's management, including the
principal executive officer and principal financial officer, concluded that the
disclosure controls and procedures were effective.
There have been no significant changes in TXU Energy's internal controls
over financial reporting for its continuing operations that have occurred during
the most recent fiscal quarter that has materially affected, or is reasonably
likely to materially affect, TXU Corp.'s internal control over financial
reporting.
11
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
Item 10 is not presented herein as TXU Energy meets the conditions set
forth in General Instruction (I) (1) (a) and (b).
Item 11. EXECUTIVE COMPENSATION
Item 11 is not presented herein as TXU Energy meets the conditions set
forth in General Instruction (I) (1) (a) and (b).
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
Item 12 is not presented herein as TXU Energy meets the conditions set
forth in General Instruction (I) (1) (a) and (b).
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Item 13 is not presented herein as TXU Energy meets the conditions set
forth in General Instruction (I) (1) (a) and (b).
Item 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
TXU Energy has no Audit Committee of its own, but relies upon the TXU
Corp. Audit Committee (Committee). The Committee has adopted a policy relating
to the engagement of TXU Corp.'s independent auditors. The policy provides that
in addition to the audit of the financial statements, related quarterly reviews
and other audit services, Deloitte & Touche LLP may be engaged to provide
non-audit services as described herein. Prior to engagement, all services to be
rendered by the independent auditors must be authorized by the Committee in
accordance with pre-approval procedures which are defined in the policy. The
pre-approval procedures require (i) the annual review and pre-approval by the
Committee of all anticipated audit and non-audit services; and (ii) the
quarterly pre-approval by the Committee of services, if any, not previously
approved and the review of the status of previously approved services. The
Committee may also approve certain on-going non-audit services not previously
approved in the limited circumstances provided for in the SEC rules. All
services performed by the independent auditor were pre-approved.
The policy defines those non-audit services which Deloitte & Touche may
also be engaged to provide as follows: (i) audit related services (e.g. due
diligence related to mergers, acquisitions and divestitures; employee benefit
plan audits; accounting and financial reporting standards consultation; internal
control reviews; and the like); (ii) tax services (e.g. Federal and state tax
returns; regulatory rulings preparation; general tax, merger, acquisition and
divestiture consultation and planning; and the like); and (iii) other services
(e.g. process improvement, review and assurance; litigation and rate case
assistance; general research; and the like). The policy prohibits the engagement
of Deloitte & Touche to provide: (i) bookkeeping or other services related to
the accounting records or financial statements of the Company; (ii) financial
information systems design and implementation services; (iii) appraisal or
valuation services, fairness opinions, or contribution-in-kind reports; (iv)
actuarial services; (v) internal audit outsourcing services; (vi) management or
human resource functions; (vii) broker-dealer, investment advisor, or investment
banking services; (viii) legal and expert services unrelated to the audit; and
(ix) any other service that the Public Company Accounting Oversight Board
determines, by regulation, to be impermissible.
Compliance with the Committee's policy relating to the engagement of
Deloitte & Touche will be monitored on behalf of the Committee by TXU Corp.'s
chief internal audit executive. Reports from Deloitte & Touche and the chief
internal audit executive describing the services provided by the firm and fees
for such services will be provided to the Committee no less often than
quarterly.
12
For the years ended December 31, 2003 and 2002, fees billed to the Company
by Deloitte & Touche were as follows:
2003 2002
------------- --------------
Audit Fees. Fees for services necessary to perform the annual audit, review
Securities and Exchange Commission filings, fulfill statutory and other attest
service requirements, provide comfort letters and consents................. $ 1,248,000 $ 1,299,000
Audit-Related Fees. Fees for services including employee benefit plan audits,
due diligence related to mergers, acquisitions and divestitures, accounting
consultations and audits in connection with acquisitions, internal control
reviews, attest services that are not required by statute or regulation, and
consultation concerning financial accounting
and reporting standards.................................................... 165,000 243,000
Tax Fees. Fees for tax compliance, tax planning, and tax advice related
to mergers and acquisitions, divestitures, and communications with and
requests for rulings from taxing authorities............................... 0 0
All Other Fees. Fees for services including process improvement
reviews, forensic accounting reviews, litigation and rate case assistance.. 102,000 140,000
------------- --------------
Total...................................................................... $1,515,000 $1,682,000
============= ==============
13
PART IV
Item 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
Page
----
(a) Documents filed as part of this Report:
Financial Statements (included in Appendix A to this report):
Selected Financial Data .............................................................. A- 2
Management's Discussion and Analysis of Financial Condition
and Results of Operations.......................................................... A- 3
Statement of Responsibility........................................................... A-33
Independent Auditors' Report.......................................................... A-34
Statements of Consolidated Income for each of the three years in the
period ended December 31, 2003..................................................... A-35
Statements of Consolidated Comprehensive Income for each of the
three years in the period ended December 31, 2003.................................. A-35
Statements of Consolidated Cash Flows for each of the three years in
the period ended December 31, 2003................................................. A-36
Consolidated Balance Sheets, December 31, 2003 and 2002............................... A-37
Statements of Consolidated Membership Interests for each of the three years in
the period ended December 31, 2003................................................. A-38
Notes to Financial Statements......................................................... A-39
The consolidated financial statement schedules are omitted because of the
absence of the conditions under which they are required or because the required
information is included in the consolidated financial statements or notes
thereto.
(b) Reports on Form 8-K filed or furnished since September 30, 2003, are as
follows:
None
(c) Exhibits:
Included in Appendix B to this report.
14
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, TXU Energy Company LLC has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
TXU ENERGY COMPANY LLC
Date: March 16, 2004
By: /s/ T. L. BAKER
------------------------------
(T. L. Baker, President and
Chief Executive)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of TXU Energy
Company LLC and in the capacities and on the date indicated.
Signature Title Date
--------- ----- ----
/s/ T. L. BAKER Principal Executive
-------------------------------------------------------- Officer and Manager March 16, 2004
(T. L. Baker, President and Chief Executive)
/s/ PAUL O' MALLEY Principal Financial Officer March 16, 2004
--------------------------------------------------------
(Paul O'Malley, Senior Vice President - Principal
Financial Officer)
/s/ DAVID H. ANDERSON Principal Accounting Officer March 16, 2004
--------------------------------------------------------
(David H. Anderson, Vice President)
/s/ C. JOHN WILDER Manager March 16, 2004
--------------------------------------------------------
(C. John Wilder, Chairman of the Board)
/s/ H. DAN FARELL Manager March 16, 2004
--------------------------------------------------------
(H. Dan Farell)
/s/ MICHAEL J. MCNALLY Manager March 16, 2004
--------------------------------------------------------
(Michael J. McNally)
/s/ ERLE NYE Manager March 16, 2004
--------------------------------------------------------
(Erle Nye)
/s/ ERIC H. PETERSON Manager March 16, 2004
--------------------------------------------------------
(Eric H. Peterson)
/s/ MICHAEL W. RANGER Manager March 16, 2004
--------------------------------------------------------
(Michael W. Ranger)
15
Supplemental Information to be Furnished with Reports Filed
Pursuant to Section 15(d) of the Act by Registrants Which Have Not Registered
Securities Pursuant to Section 12 of the Act
No annual report, proxy statement, form of proxy or other proxy soliciting
material has been sent to security holders of TXU Energy Company LLC during the
period covered by this Annual Report on Form 10-K for the fiscal year ended
December 31, 2003.
16
Appendix A
TXU ENERGY COMPANY LLC AND SUBSIDIARIES
INDEX TO FINANCIAL INFORMATION
December 31, 2003
Page
Selected Financial Data .................................................................... A-2
Management's Discussion and Analysis of Financial Condition and Results of Operations....... A-3
Statement of Responsibility................................................................. A-33
Independent Auditors' Report................................................................ A-34
Financial Statements:
Statements of Consolidated Income and Comprehensive Income............................... A-35
Statements of Consolidated Cash Flows.................................................... A-36
Consolidated Balance Sheets.............................................................. A-37
Statements of Consolidated Membership Interests.......................................... A-38
Notes to Financial Statements............................................................ A-39
A-1
TXU ENERGY COMPANY LLC AND SUBSIDIARIES
SELECTED FINANCIAL DATA
Year Ended December 31,
------------------------------------------
2003 2002 2001 2000
---- ---- ---- ----
(Millions of Dollars, except ratios)
Total assets -- end of year................................ $14,572 $15,789 $13,905 $14,775
Property, plant and equipment - net -- end of year......... $10,381 $10,380 $10,530 $10,650
Capital expenditures................................... $ 163 $ 284 $ 327 $ 254
Capitalization -- end of year
Long-term debt, less amounts due currently ............ $ 3,084 $ 2,378 $ 3,454 $ 3,196
Exchangeable preferred membership interests............ 497 - - -
Membership interests................................... 3,999 4,273 4,212 4,121
------- ------- ------- -------
Total..................................... $ 7,580 $ 6,651 $ 7,666 $ 7,317
======= ======= ======= =======
Capitalization ratios -- end of year
Long-term debt, less amounts due currently............. 40.7% 35.8% 45.1% 43.7%
Exchangeable preferred membership interests............ 6.6 - - -
Membership interests................................... 52.7 64.2 54.9 56.3
------- ------- ------ -------
Total..................................... 100.0% 100.0% 100.0% 100.0%
======= ======= ====== =======
Embedded interest cost on long-term debt and exchangeable
preferred membership interests -- end of year (a)........ 7.2% 6.8% 4.5% 5.9%
Operating revenues......................................... $ 7,995 $ 7,691 $ 7,404 $ 7,392
Income from continuing operations before extraordinary loss
and cumulative effect of changes in accounting
principles................................................ 493 319 591 581
Net income.................................................. 421 270 507 576
Ratio of earnings to fixed charges........................ 2.93 2.63 3.96 3.64
(a) Represents the annual interest and amortization of any discounts, premiums,
issuance costs and any deferred gains/losses on reacquisitions divided by
the carrying value of the debt plus or minus the unamortized balance of any
discounts, premiums, issuance costs and gains/losses on reacquisitions at
the end of the year.
Certain previously reported financial statistics have been reclassified to
conform to current classifications.
Prior year amounts have been restated to reflect the retail strategic business
as discontinued operations. (See Note 3 to Financial Statements.)
A-2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
BUSINESS
Use of the term "TXU Energy", unless otherwise noted, refers to TXU Energy
Company LLC, a holding company, and/or its consolidated subsidiaries.
TXU Energy engages in power production (electricity generation) and retail
and wholesale sales of electricity and natural gas. TXU Energy engages in
hedging and risk management activities to mitigate commodity price risk.
TXU Energy has no reportable segments.
Changes in Business
- -------------------
In December 2003, TXU Energy finalized a formal plan to sell its strategic
retail services business, which is engaged principally in providing energy
management services. The consolidated financial statements for all years
presented reflect the reclassification of the results of this business as
discontinued operations. (See Note 3 to Financial Statements for more detailed
information about discontinued operations.)
All dollar amounts in Management's Discussion and Analysis of Financial
Condition and Results of Operations and the tables therein, except per share
amounts, are stated in millions of US dollars unless otherwise indicated.
MANAGEMENT'S CHALLENGES AND INITIATIVES
Management Change
- -----------------
On February 23, 2004, C. John Wilder was named president and chief
executive of TXU Corp. Mr. Wilder was formerly executive vice president and
chief financial officer of Entergy Corporation. Mr. Wilder is in the process of
reviewing the operations of TXU Corp. and formulating strategic initiatives.
This review is expected to take up to six months. Upon completion, TXU Corp.
expects to fully describe the results of the review and subsequent actions
intended to improve the financial performance of its operations.
Areas to be reviewed include:
o Performance in competitive markets, including profitability in new
markets
o Cost structure, including organizational alignments and headcount
o Management of natural gas price risk
o Non-core business activities
If any new strategic initiatives are undertaken, TXU Corp.'s financial
results could be materially affected.
Competitive Markets
- -------------------
In the Texas market, 2003 was the second full year of competitive
activity, and that activity has impacted customer counts and sales volumes. The
area representing the historical service territory prior to deregulation,
largely in north Texas, consisted of approximately 2.8 million consumers
(measured by meter counts) as of year-end of 2003. TXU Energy currently has
approximately 2.4 million customers in that territory and has acquired
approximately 200,000 customers in other competitive areas in Texas. Total
customer counts declined 4% in 2003 and 0.5% in 2002. Retail sales volumes
declined 12% in 2003 and 9% in 2002, reflecting competitive activity in the
business market segment and to a lesser extent in the residential market. While
wholesale sales volumes have increased significantly, gross margins have been
compressed by the loss of the higher-margin retail volumes. TXU Energy intends
to aggressively compete, in terms of price and customer service, in all segments
of the retail market, both within and outside the historical service territory.
In particular, TXU Energy anticipates regaining volumes in the large business
market, reflecting contracting activity in late 2003. Because of the customer
service and marketing costs associated with entering markets outside of the
historical service territory, TXU Energy has experienced operating losses in
these new markets. TXU Energy expects to be profitable in these markets as the
customer base grows and economies of scale are achieved, but uncertainties
remain and objectives may not be achieved.
A-3
Effect of Natural Gas
- ---------------------
Wholesale electricity prices in the Texas market generally move with the
price of natural gas because marginal demand is met with gas-fired generation
plants. Natural gas prices increased significantly in 2003, but historically the
price has moved up and down due to the effects of weather, industrial demand,
supply availability and other economic factors. Consequently, sales price
management and hedging activities are critical in achieving targeted gross
margins. TXU Energy continues to have price flexibility in the large business
market and effective January 1, 2004, has price flexibility in the small
business market including the historical service territory. With respect to
residential customers in the historical service territory, TXU Energy is subject
to regulated "price-to-beat" rates, but such rates can be adjusted up or down
twice a year at TXU Energy's option, subject to approval by the Commission,
based on changes in natural gas prices. The challenge in adjusting these rates
is determining the appropriate timing, considering past and projected movements
in natural gas prices, such that targeted margins can be achieved while
remaining competitive with other retailers who have price flexibility. TXU
Energy increased the price-to-beat rates twice in 2003, and these actions
combined with unregulated price increases and hedging activities essentially
offset higher costs of energy sold as compared to 2002.
In its portfolio management activities, TXU Energy enters into physical
and financial energy-related (power and natural gas) contracts to hedge gross
margins. TXU Energy hedges prices of anticipated power sales against falling
natural gas prices and, to a lesser extent, hedges costs of energy sold against
rising natural gas prices. The results of hedging and risk management activities
can vary significantly from one reporting period to the next as a result of
market price movements on the values of hedging instruments. Such activity
represents an effective management tool to reduce cash gross margin risk over
time. The challenge, among others, with these activities is managing the
portfolio of positions in a market in which prices can move sharply in a short
period of time.
One of TXU Energy's cost advantages, particularly in a time of rising
natural gas prices, is its nuclear-powered and coal/lignite-fired generation
assets. Variable costs of this "base load" generation, which provided
approximately 50% of sales volumes in 2003, have in recent history been, and are
expected to be, less than the costs of gas-fired generation. Consequently,
maintaining the efficiency and reliability of the base load assets is of
critical importance in managing gross margin risk. Completing scheduled
maintenance outages at the nuclear-powered facility on a timely basis, for
example, is a critical management process. Because of the correlation of power
and natural gas prices in the Texas market, structural decreases or increases in
natural gas prices that are sustained over a multi-year period result in a
correspondingly lower or higher value of TXU Energy's base load generation
assets.
Operating Costs and SG&A Expenses
- ---------------------------------
With the transition from a fully regulated environment to competition in
the retail and wholesale electricity markets, TXU Energy continues to seek
opportunities to enhance productivity, reduce complexity and improve the
effectiveness of its operating processes. Such efforts are balanced against the
need to support growth and maintain the reliability, efficiency, and security of
its generation fleet. Cost reduction initiatives have resulted in lower
headcounts, the exiting of marginal business activities and reduced
discretionary spending. Total operating costs and SG&A expenses in TXU Energy's
continuing operations declined $149 million, or 10%, in 2003. These costs
include TXU Corp. corporate expenses allocated to TXU Energy. While upward cost
pressures are expected for competitive sales and marketing initiatives, customer
care and support activities, and employee and retiree benefits, increasing
productivity levels will continue to be a management priority.
CRITICAL ACCOUNTING POLICIES
TXU Energy's significant accounting policies are detailed in Note 1 to
Financial Statements. TXU Energy follows accounting principles generally
accepted in the United States of America. In applying these accounting policies
in the preparation of TXU Energy's consolidated financial statements, management
is required to make estimates and assumptions about future events that affect
the reporting and disclosure of assets and liabilities at the balance sheet
dates and revenue and expense during the periods covered. The following is a
summary of certain critical accounting policies of TXU Energy that are impacted
by judgments and uncertainties and for which different amounts might be reported
under a different set of conditions or using different assumptions.
A-4
Financial Instruments and Mark-to-Market Accounting -- TXU Energy enters
into financial instruments, including options, swaps, futures, forwards and
other contractual commitments primarily to hedge market risks related to changes
in commodity prices as well as changes in interest rates. These financial
instruments are accounted for in accordance with SFAS 133 as well as, prior to
October 26, 2002, EITF 98-10. The majority of financial instruments entered into
by TXU Energy and used in hedging activities are derivatives as defined in SFAS
133.
SFAS 133 requires the recognition of derivatives in the balance sheet, the
measurement of those instruments at fair value and the recognition in earnings
of changes in the fair value of derivatives. This recognition is referred to as
"mark-to-market" accounting. SFAS 133 provides exceptions to this accounting if
(a) the derivative is deemed to represent a transaction in the normal course of
purchasing from a supplier and selling to a customer, or (b) the derivative is
deemed to be a cash flow or fair value hedge. In accounting for cash flow
hedges, derivative assets and liabilities are recorded on the balance sheet at
fair value with an offset in other comprehensive income. Amounts are
reclassified from other comprehensive income to earnings as the underlying
transactions occur and realized gains and losses are recognized in earnings.
Fair value hedges are recorded as derivative assets or liabilities with an
offset to the carrying value of the related asset or liability. Any hedge
ineffectiveness related to cash flow and fair value hedges is recorded in
earnings.
TXU Energy documents designated commodity, debt-related and other hedging
relationships, including the strategy and objectives for entering into such
hedge transactions and the related specific firm commitments or forecasted
transactions. TXU Energy applies hedge accounting in accordance with SFAS 133
for these non-trading transactions, providing the underlying transactions remain
probable of occurring. Effectiveness is assessed based on changes in cash flows
of the hedges as compared to changes in cash flows of the hedged items. In its
risk management activities, TXU Energy hedges future electricity revenues using
natural gas instruments; such cross-commodity hedges are subject to
ineffectiveness calculations that can result in mark-to-market gains and losses.
Pursuant to SFAS 133, the normal purchase or sale exception and the cash
flow hedge designation are elections that can be made by management if certain
strict criteria are met and documented. As these elections can reduce the
volatility in earnings resulting from fluctuations in fair value, results of
operations could be materially affected by such elections.
Interest rate swaps entered into in connection with indebtedness to manage
interest rate risks are accounted for as cash flow hedges if the swap converts
rates from variable to fixed and are accounted for as fair value hedges if the
swap converts rates from fixed to variable.
EITF 98-10 required mark-to-market accounting for energy-related
contracts, whether or not derivatives under SFAS 133, that were deemed to be
entered into for trading purposes as defined by that rule. The majority of
commodity contracts and energy-related financial instruments entered into by TXU
Energy to manage commodity price risk represented trading activities as defined
by EITF 98-10 and were therefore marked-to-market. On October 25, 2002, the EITF
rescinded EITF 98-10. Pursuant to this rescission, only financial instruments
that are derivatives under SFAS 133 are subject to mark-to-market accounting.
In June 2002, in connection with the EITF's consensus on EITF 02-3,
additional guidance on recognizing gains and losses at the inception of a
trading contract was provided. In November 2002, this guidance was extended to
all derivatives. As a result, effective in 2003, TXU Energy discontinued
recording mark-to-market gains on inception of energy contracts. See discussion
below in Results of Operations - "Commodity Contracts and Mark-to-Market
Activities."
Mark-to-market accounting recognizes changes in the value of financial
instruments as reflected by market price fluctuations. In the energy market, the
availability of quoted market prices is dependent on the type of commodity
(e.g., natural gas, electricity, etc.), time period specified and location of
delivery. In computing the mark-to-market valuations, each market segment is
split into liquid and illiquid periods. The liquid period varies by region and
commodity. Generally, the liquid period is supported by broker quotes and
frequent trading activity. In illiquid periods, little or no market information
may exist, and the fair value is estimated through market modeling techniques.
A-5
For those periods where quoted market prices are not available, forward
price curves are developed based on available information or through the use of
industry accepted modeling techniques and practices based on market fundamentals
(e.g., supply/demand, replacement cost, etc.). TXU Energy does not recognize any
income or loss from the illiquid periods unless credible price discovery exists.
TXU Energy recorded net unrealized losses arising from mark-to-market
accounting, including hedge ineffectiveness, of $100 million and $113 million in
2003 and 2002, respectively. The 2003 amount excludes the cumulative effect of
changes in accounting principles discussed in Note 2 to Financial Statements.
Revenue Recognition -- TXU Energy records revenue for retail and wholesale
energy sales under the accrual method. Retail electric revenues are recognized
when electricity is provided to customers on the basis of periodic cycle meter
readings and include an estimated accrual for the value of electricity consumed
from the meter reading date to the end of the period. The unbilled revenue is
calculated at the end of the period based on estimated daily consumption after
the meter read date to the end of the period. Estimated daily consumption is
derived using historical customer profiles adjusted for weather and other
measurable factors affecting consumption. Unbilled revenues reflected in
accounts receivable totaled $388 million and $489 million at December 31, 2003
and 2002, respectively.
Realized and unrealized gains and losses from transacting in
energy-related contracts, principally for the purpose of hedging margins on
sales of energy, are reported as a component of revenues. As discussed above
under "Financial Instruments and Mark-to-Market Accounting," recognition of
unrealized gains and losses involves a number of assumptions and estimates that
could have a significant effect on reported revenues and earnings.
Accounting for Contingencies -- The financial results of TXU Energy may be
affected by judgments and estimates related to loss contingencies. Accruals for
loss contingencies are recorded when management determines that it is probable
that an asset has been impaired or a liability has been incurred and that such
economic loss can be reasonably estimated. Such determinations are subject to
interpretations of current facts and circumstances, forecasts of future events
and estimates of the financial impacts of such events.
A significant contingency that TXU Energy accounts for is the loss
associated with uncollectible trade accounts receivable. The determination of
such bad debts expense is based on factors such as historical write-off
experience, agings of accounts receivable balances, changes in operating
practices, regulatory rulings, general economic conditions and customers'
behaviors. With the opening of the Texas electricity market to competition, many
historical measures used to estimate bad debt experience may be less reliable.
The changing environment, including recent regulatory changes that allow REPs in
their historical service territories to disconnect non-paying customers, and
customer churn due to competitor actions has added a level of complexity to the
estimation process. Bad debt expense totaled $114 million and $155 million for
the years ended December 31, 2003 and 2002, respectively.
In connection with the opening of the Texas market to competition, the
Texas Legislature established a retail clawback provision intended to incent
affiliated REPs of utilities to actively compete for customers outside their
historical service territories. A retail clawback liability arises unless 40% of
the electricity consumed by residential and small business customers in the
historical service territory is supplied by competing REPs after the first two
years of competition. This threshold was reached for small business customers in
2003, but not for residential customers. The amount of the liability is equal to
the number of such customers retained by TXU Energy as of January 1, 2004, less
the number of new customers from outside the historical service territory,
multiplied by $90. The credit, which will be funded by TXU Energy, will be
applied to delivery fees charged by Oncor to REPs, including TXU Energy, over a
two-year period beginning January 1, 2004. In 2002, TXU Energy recorded a charge
to cost of energy sold and delivery fees of $185 million ($120 million
after-tax) to accrue an estimated retail clawback liability. In 2003, TXU Energy
reduced the liability to $173 million, with a credit to cost of energy sold and
delivery fees of $12 million ($8 million after-tax), to reflect the calculation
of the estimated liability applicable only to residential customers in
accordance with the Settlement Plan.
ERCOT Settlements - ERCOT's responsibilities include the balancing and
settlement of electricity volumes and related ancillary services among the
various participants in the deregulated Texas market. ERCOT settles balancing
energy with market participants through a load and resource imbalance charge or
credit for any differences between actual and scheduled volumes. Ancillary
services and various fees are allocated to market participants based on each
participant's load.
A-6
Settlement information is due from ERCOT within two months after the
operating day, and true-up settlements are due from ERCOT within twelve months
after the operating day. The ERCOT settlement process has been delayed several
times to address operational data management problems between ERCOT, the
transmission and distribution service providers and the REPs. These operational
data management issues are related to new processes and systems associated with
opening the ERCOT market to competition, which have continued to improve.
True-up settlements have been received for 2002, but true-up settlements for the
year 2003 are currently scheduled to start on June 1, 2004. All periods continue
to be subject to a dispute resolution process.
As a result of the delay in the ERCOT settlements and the normal time lags
described above, TXU Energy's operating revenues and costs of energy sold
contain estimates for load and resource imbalance charges or credits with ERCOT
and for ancillary services and related fees that are subject to change and may
result in charges or credits impacting future reported results of operations.
The amounts recorded represent the best estimate of these settlements based on
available information. During 2003, TXU Energy recorded a net expense of $20
million to adjust amounts previously recorded for 2002 and 2001 ERCOT
settlements.
Impairment of Long-Lived Assets -- TXU Energy evaluates long-lived assets
for impairment whenever indications of impairment exist, in accordance with the
requirement of SFAS 144. One of those indications is a current expectation that
"more likely than not" a long-lived asset will be sold or otherwise disposed of
significantly before the end of its previously estimated useful life. The
determination of the existence of this and other indications of impairment
involves judgments that are subjective in nature and in some cases requires the
use of estimates in forecasting future results and cash flows related to an
asset or group of assets. Further, the unique nature of TXU Energy's property,
plant and equipment, which includes a fleet of generation assets using different
fuels and individual plants that have varying utilization rates, requires the
use of significant judgments in determining the existence of impairment
indications and grouping assets for impairment testing.
In 2002, TXU Energy recorded an impairment charge of $237 million ($154
million after-tax) for the writedown of two generation plant construction
projects as a result of weaker wholesale electricity market conditions and
reduced planned developmental capital spending. Fair value was determined based
on appraisals of property and equipment. The charge is reported in other
deductions.
Goodwill and Intangible Assets - TXU Energy evaluates goodwill for
impairment at least annually (as of October 1) in accordance with SFAS 142. The
impairment tests performed are based on discounted cash flow analyses. Such
analyses require a significant number of estimates and assumptions regarding
future earnings, working capital requirements, capital expenditures, discount
rate, terminal year growth factor and other modeling factors. No goodwill
impairment has been recognized for consolidated reporting units reflected in
results from continuing operations.
Defined Benefit Pension Plans and Other Postretirement Benefit Plans-- TXU
Energy is a participating employer in the defined benefit pension plan sponsored
by TXU Corp. TXU Energy also participates with TXU Corp. and other affiliated
subsidiaries of TXU Corp. to offer health care and life insurance benefits to
eligible employees and their eligible dependents upon the retirement of such
employees. See Note 11 to Financial Statements for information regarding
retirement plans and other postretirement benefits.
These costs are impacted by actual employee demographics (including age,
compensation levels and employment periods), the level of contributions made to
retiree plans and earnings on plan assets. TXU Corp.'s retiree plan assets are
primarily made up of equity and fixed income investments. Changes made to the
provisions of the plans may also impact current and future benefit costs.
Fluctuations in actual equity market returns as well as changes in general
interest rates may result in increased or decreased benefit costs in future
periods. Benefit costs may also be significantly affected by changes in key
actuarial assumptions, including anticipated rates of return on plan assets and
the discount rates used in determining the projected benefit obligation.
In accordance with accounting rules, changes in benefit obligations
associated with these factors may not be immediately recognized as costs on the
income statement, but are recognized in future years over the remaining average
service period of plan participants. As such, significant portions of benefit
costs recorded in any period may not reflect the actual level of cash benefits
provided to plan participants. Costs allocated from the plans are also impacted
by movement of employees between participating companies. TXU Energy recorded
allocated pension and other postretirement benefits expense of $58 million in
2003, $32 million in 2002 and $19 million in 2001. TXU Energy's funding
requirements for these plans were $29 million, $20 million and $20 million in
2003, 2002 and 2001, respectively.
A-7
During 2003, key assumptions of the US pension and other postretirement
benefit plans were revised, including decreasing the assumed discount rate in
2003 from 6.75% to 6.25% to reflect current interest rates. The expected rate of
return on pension plan assets remained at 8.5%, but declined to 8.01% from 8.26%
for the other postretirement benefit plan assets.
Based on current assumptions, pension and other postretirement benefits
expense for TXU Energy is expected to increase $9 million to approximately $67
million in 2004, and TXU Energy's funding requirements for these plans are
expected to increase $16 million to approximately $45 million.
As a result of the pension plan asset return experience, at December 31,
2002, TXU Corp. recognized a minimum pension liability as prescribed by SFAS 87.
TXU Energy's allocated portion of the liability, which totaled $60 million ($39
million after-tax), was recorded as a reduction to shareholders' equity through
a charge to Other Comprehensive Income. At December 31, 2003, the minimum
pension liability reflects a reduction of $37 million ($25 million after-tax) as
a result of improved returns on the plan assets. The changes in the minimum
pension liability do not affect net income.
TXU Corp. has elected not to defer accounting for the Medicare
Prescription Drug, Improvement and Modernization Act of 2003 (the Medicare Act)
as allowed for under FASB Staff Position 106-1. TXU Corp. believes that the plan
in which TXU Energy is a participant meets the actuarial equivalency as required
by the Medicare Act and therefore a reduction in future postretirement benefit
costs is expected. Further information related to the impact of the Medicare Act
can be found in the 2003 TXU Corp. Form 10-K The Medicare Act had no effect on
TXU Energy's results of operations for 2003, but is expected to reduce TXU
Energy's postretirement benefits expense other than pensions by approximately
$11 million in 2004.
A-8
RESULTS OF OPERATIONS
Operating Data
- --------------
Year Ended December 31,
------------------------------------
2003 2002 2001(a)(b)
---- ---- ----------
Operating statistics - volumes:
Retail electricity (GWh)
Residential.............................................. 35,981 37,692
Small business(c)........................................ 12,986 15,907
Large business and other................................. 30,955 36,982
------ ------
Total retail electricity............................... 79,922 90,581 99,151
====== ====== ======
Wholesale electricity (GWh)................................. 37,362 29,649 6,409
====== ====== ======
Production and purchased power (GWh):
Nuclear and lignite/coal (base load)..................... 59,028 54,738 57,828
Gas/oil and purchased power.............................. 63,319 70,321 52,925
------ ------ ------
Total production and purchased power .................. 122,347 125,059 110,753
======= ======= =======
Customer counts:
Retail electricity customers (end of period & in thousands -
based on number of meters):
Residential.............................................. 2,207 2,302
Small business........................................... 321 333
Large business and other................................. 69 78
------ ------ ------
Total retail electricity customers..................... 2,597 2,713 2,728
====== ====== ======
Operating revenues (millions of dollars):
Retail electricity revenues:
Residential.............................................. $3,311 $3,108 $3,255
Business and other ...................................... 3,173 3,415 3,837
------ ------ -----
Total retail electricity revenues...................... 6,484 6,523 7,092
Wholesale electricity revenues ............................. 1,274 857 96
Hedging and risk management activities...................... 18 142 358
Other revenues.............................................. 219 169 (142)
------ ------ ------
Total operating revenues............................... $7,995 $7,691 $7,404
====== ====== ======
Weather (average for service territory) (d)
Percent of normal:
Cooling degree days.................................... 103.1% 99.8% 100.5%
Heating degree days.................................... 94.0% 102.0% 97.5%
- --------------------------
(a) Data for 2001 is included above for the purpose of providing historical
financial information about TXU Energy after giving effect to the
restructuring transactions and unbundling allocations described in
Note 1 to Financial Statements. Allocations reflected in 2001
data did not necessarily result in amounts reported in individual
line items that are comparable to actual results in 2002 and 2003.
Had TXU Energy existed as a separate entity in 2001, its results
of operations and financial position could have differed materially
from those reflected above.
(b) Retail volume and customer count data for 2001 not available by class.
(c) Customers with demand of less than 1MW annually.
(d) Weather data is obtained from Meteorlogix, an independent company that
collects weather data from reporting stations of the National Oceanic
and Atmospheric Administration (a federal agency under the US Department
of Commerce).
The results of operations and the related management's discussion of those
results for all periods presented reflect the discontinuance of certain
operations of TXU Energy (see Note 3 to Financial Statements regarding
discontinued operations) and the reclassifications of losses in 2001 on early
extinguishments of debt from extraordinary loss to other deductions in
accordance with SFAS 145. (See Note 1 to Financial Statements.)
A-9
TXU Energy
- ----------
2003 compared to 2002
- ---------------------
Operating revenues increased $304 million, or 4%, to $8.0 billion in 2003.
Total retail and wholesale electricity revenues rose $378 million, or 5%, to
$7.8 billion. This growth reflected higher retail and wholesale pricing,
partially offset by the effects of a mix shift to lower-price wholesale sales
and a 2% decline in total sales volumes. Retail electricity revenues decreased
$39 million, or 1%, to $6.5 billion reflecting a $768 million decline
attributable to a 12% drop in sales volumes, driven by the effect of competitive
activity in the business market, largely offset by a $730 million increase due
to higher pricing. Higher prices reflected increased price-to-beat rates, due to
approved fuel factor increases, and higher contract pricing in the competitive
large business market, both resulting from higher natural gas prices. Retail
electricity customer counts declined 4% from year-end 2002. Wholesale
electricity revenues grew $417 million, or 49%, to $1.3 billion reflecting a
$223 million increase attributable to a 26% rise in sales volumes and a $194
million increase due to the effect of increased natural gas prices on wholesale
prices. Higher wholesale electricity sales volumes reflected a partial shift in
the customer base from retail to wholesale services, particularly in the
business market.
Net gains from hedging and risk management activities, which are reported
in revenues and include both realized and unrealized gains and losses, declined
$124 million to $18 million in 2003. Changes in these results reflect market
price movements on commodity contracts entered into to hedge gross margin; the
comparison to 2002 also reflects a decline in activities in markets outside of
Texas. Because the hedging activities are intended to mitigate the risk of
commodity price movements on revenues and cost of energy sold, the changes in
such results sho